where orders emerge

Getting the Point of Economics

Cafe patron Stephen Schmalhofer sent this e-mail to me today. I post it here in full, with Steve’s generous permission.

I hated freshman economics at Yale. It was the only C I ever received. Taught in a massive lecture hall, the professor posted endless equations and formulas. It wasn’t real. My father was the CEO of a poultry company in rural Pennsylvania. I wandered the plant as a child and saw chickens raised in Pennsylvania, fed soybeans from Brazil, transported by trucks assembled in Detroit and Kentucky, processed by special machinery built in the Netherlands and operated by workers from Mexico, Honduras, Guatemala and finally shipped around the world. (Even the feet were sold to China) This is economics and it isn’t boring! It’s gorgeous, like the spontaneously coordinating steps of a couple on the dance floor, a flock of birds or a school of fish. It’s the delightfully humanizing marketplace- that virtual site of exchange where a man from Chile trades with a woman from France as though they are neighbors.

I’ve often annoyed friends by repeating my view that “Prices are beautiful.” We have a tendency to view prices as deception, a trick played on consumers to scam us into paying more than we like. Prices are information. Like ants tracing pheremones, prices provide signals for the billions of buyers and sellers that we call “the market.” These prices guide our savings, our production and our consumption. Isn’t it marvelous how we can use a price to evaluate all 3 of those functions? Prices are like a universal language! (But far superior to Esperanto)

Our preferences conflict as multiple people want the same item. How do we resolve this? You could take it by force. You could plead your case before a judge. You could lobby a Senator for a favor. You could stand in line and submit a request to a bureaucrat. Or you could express your desire for the good directly to the person selling the item you desire. The seller can then compare the intensity of your desire to that of other interested buyers. We express the intensity of our desires (and our willingness to sell) with little tags of information called Prices!

Why study economics? Ask someone in Times Square and he might say: “To learn how to build a business.” Curiously, the study of economics reveals the opposite: we learn how little we can create. Economics will humble you. Think you’re smart?

I am unfailingly saddened when I reflect on how principles of economics is generally taught today – taught as if gaining an understanding of the mathematics of equations and graphs that feature variables with economics-sounding names such as “price,” “quantity,” “utility,” and “imports” is to gain an understanding of the logic of the operation of real-world economies.

Now I myself, in my principles-of-economics courses, use graphs and some equations. These can be useful – indeed, in the case of supply-and-demand graphs, damn near indispensable. But to make them useful requires that they be always related to real-world phenomena, and related deeply and compellingly with stories, anecdotes, metaphores, examples.

Comments

Even supply and demand is an abstraction that isn’t exactly like the real world. In the real world, prices are events not properties of supply and demand, and things only reduce to supply and demand graphs when a market is liquid enough (or one is averaging over a large enough time period). At very small time intervals with or low liquidity, or low entropy, demand and supply models aren’t very satisfactory.

“Even supply and demand is an abstraction that isn’t exactly like the real world.”

Like a single abstract trade between two individuals, it merely captures, in a true way, an important aspect of the real world. It allows some real insight into a hopelessly complex order. And it is logically deduced from fundamentals.

I think your issue with it is when people claim they can use it as a useful empirical model for a real concrete problem. It’s bad enough when this is claimed for macro phenomena, but is rarely useful for predictions even in much smaller systems.

Right – anyone that can’t communicate this underlying logic and the reality that the modeling describes shouldn’t be teaching economics.

What’s unfortunate is that he was turned off to the modeling, because the good modeling does capture reality (or else it’s rejected – and that process of testing and rejecting is good too). When people get turned off by the modeling it is understandable but not a good thing. It would be like someone enjoying the stars but giving up on astrophysics. Star-gazing is nice, and getting a sense of the universe by star-gazing is great, but you completely miss the fact that astrophysics makes our appreciation of the universe stronger if you harbor a suspicion of the science because of a bad experience in school.

Good educators that make economics intuitive and interesting are essential.

Mark TApril 6, 2011 at 10:33 am

That’s a great comment but I think the issue with modeling as to a large complex world is that it is has to be so incredibly reductionist to communicate anything, which then renders it accurate.

And confidence in the results and the extent of projections into the future are going to be calibrated accordingly.

It seems to me that the people with the most “physics envy” are the economists that make the “physics envy” accusation. Clearly modeling a complex system is not going to capture dynamics in the same way that modeling a mechanical system will. I make this point regularly on here. People who use these models rarely treat it as if it does.

Again, with good educators I think this point will be communicated. With bad educators, you’re going to scare people away either because they think economics is boring or because they think it is broken.

The graphs and charts are best used for a business to calculate production. Too much, and they risk loss of unsold items and loss of value of product due to oversupply. Too little, and they risk losing out on sales and not satisfying customer base, sending them to a competitor and likely loss of customer for some time to come. I think this assertion is a little too simple and missing some more important elements. But, that is as far as I can go as this time.

yet another DaveApril 6, 2011 at 11:02 am

…the good modeling does capture reality…

To the extent that’s true (if it is at all) in economic models, it is an illusory and temporary capture. Even the very best of the best models must necessarily ignore many trillions of pertinent variables and make various simplifying assumptions. As long as reality stays similar to the simplifying assumptions and the trillions of ignored variables more or less average out, the model “predicts” reality. But as soon as any of these conditions changes, the model is suddenly revealed to be the useless oversimplification it always was, and it will no longer predict anything close to reality. The real kicker is the model has no way to anticipate when such a transformation will happen (because it’s based on things the model ignores).

Picture trying to curve-fit a complex shape on a graph – claiming the best economic models capture reality is like fitting a small portion of the shape and claiming to have a curve-fit solution. There is no curve fit solution, because a little further right or left it no longer fits.

Welcome to the science of complex systems, yet another dave. What do you want me to do about it?

Again, as I said above, the only people who seem to have physics-envy-esque expectations of economics are the very people who hurl that accusation.

But even aside from the issue of complexity, what you’re describing is how all science works – including physics. This is how things advance – you work through the implications of a model until it simply doesn’t work any more, and then you develop a new model that works better. You act like this is some great betrayal, but this is science, yet another dave. That’s how it progresses.

yet another DaveApril 6, 2011 at 11:54 am

You continue to struggle with comprehension – I have no idea how you could have divined this particularly bizarre nugget:

You act like this is some great betrayal

The whole “physics-envy” tangent is also coming from someplace unrelated to this discussion. Very strange…

To answer your question “What do you want me to do about it?” I would call for some humility. Don’t make such a preposterous claim as “the good modeling does capture reality.” It doesn’t.

I’m well aware of how science works (given our backgrounds, likely much better than you are). While your description of progress is generally correct, it has absolutely nothing to do with my point. Perhaps at some point in the future, economic models will have advanced to the point where they do predict reality for more than just a fleeting slice of time. I’m skeptical, given that the model must account for many trillions of individual human decisions and those decisions are based on innumerable variables that simple cannot be known. Your fondness for aggregates may make you more optimistic, but either way, they’re just not there yet.

Climate modeling is easy compared with economic modeling (because the actors in climate are physically deterministic), and climate modeling isn’t even slightly close to predicting reality yet. Welcome to the science of complex systems.

re: “To answer your question “What do you want me to do about it?” I would call for some humility”

And yet when humility is repeatedly expressed people like you continue to act like it’s not. Whose reading comprehension is questionable here?

The physics envy point has everything to do with your comment, btw. You might not have been planning on bringing it in, but the question of the precision of estimates and the amount of variabels in the system that we can model is central to the complaint of physics envy.

What’s amazing to me about you is that you state the obvious about economics, act haughty as if we don’t realize this and haven’t said it ourselves, and then blame us for not approaching the work cognizant of those constraints without recognizing that we do. It gets old, yet another dave.

I suppose I just don’t understand why you’re comparing it to forecasts of physically deterministic complex systems. Compare it to retrospective studies of non-deterministic complex systems like evolutionary biology, or – when you look at economic forecasts – try some realism and note that economic forecasters are aware of the precision of their estimates of complex systems and therefore don’t project all the far into the future (and when they do, they caveat, qualify, and approach it with humility).

My concern with you is that you’re either:
1. Making the wrong comparisons
2. Making the right comparisons but you remain completely ignorant of the fact that we adhere to those comparisons, and
3. Ask things like “humility” of us which we already practice.

You can understand how your approach along these lines can lead me to question if you really understand your own criticism.

yet another DaveApril 6, 2011 at 12:28 pm

danny,
Your 2 replies make absolutely no sense. None of your comments has anything to do with what I’m saying. Not even one of your conclusions or inferences has any connection with reality. Either you’re having a discussion with the voices in your head based on some wildly distorted perception of who I am and what I say and think, or you’re just stuck in transmit mode. I’ll leave you to that.

It’s an exciting time for learning and teaching economics. I majored in economics at UC Santa Cruz before studying engineering at Berkeley, and I fell asleep in every single Microeconomics 1A lecture my first quarter of college.

Before finding Cafe Hayek and Econtalk, and just after reading Basic Economics I was jazzed about economics, and I was eager to get my former econ classmates more excited about it. Not a chance. They laughed about the usefulness of the economics education we received and probably still believe it’s a useless, wannabe science. I was disappointed with their reaction, but now realize (after listening to Econtalk and following Cafe Hayek) that economics can be taught in a far more interesting and useful way that it is at most universities.

I just got off the Fear the Boom and Bust Sequel Preview conference call with Dr. Roberts and John Papola and now I’m more excited that ever about economics. I feel like going out and buying a movie camera so I can make my own economics videos.

Thanks for sharing Don and Stephen.

E.G.April 5, 2011 at 5:38 pm

I got a D in Advanced Microecon. It was a god-awful class. While all of you professors say “well if you aren’t a good professor and can’t convey these feelings, you shouldn’t be teaching!”, most professors don’t come close to conveying these feelings to us non-economists.

Either way, computer simulations exist to make the concepts more interactive and “relevant” for non-econ majors. Some are quite good. So at this stage of the game, there’s no excuse for such poor economics instruction.

Dr. TApril 5, 2011 at 6:02 pm

Tennessee recently added basic economics as a required class to graduate high school. (And, relevant to a previous post, Tennessee also requires Algebra 2.) My younger daughter is taking economics. Most students in Tennessee’s public high schools are uninterested in the subject (boring texts and boring teachers), and, to assure that almost all seniors pass the course and graduate, it is taught at a level appropriate for a 12-year-old with an IQ of 90. My daughter knows, because of our dinner table discussions, that economics is more interesting and more relevant that what is taught. She hopes to become a book editor, and some knowledge of economics will be useful, especially when explaining to an author why a book’s royalties are so low.

PfloydApril 5, 2011 at 6:06 pm

While I enjoy mathematics and models and graphs, I understand that using those things tends to confuse rather than illuminate.

Something that all of us in general–and economics academics especially–should remember is that all models are wrong but some models are useful. Economists need to let go of their “physicist envy” and realize the limitations of their field.

I, like Stephen, also have seen the beauty of real-life economics. I worked in industrial management for a few years before deciding to go back to school to study economics formally. One of the anecdotes I have often cited is when my old company outsourced 50 jobs to Mexico which allowed us to cut costs enough to eventually invest in facilities in two other states closer to our suppliers which led to 150 jobs being created in those locations. So while we lost 50 jobs at one place, a town in Mexico got 50 jobs and 150 new jobs were created on American soil too. But what do the headlines read? “Greedy, local manufacturers outsources 50 welding jobs to Mexico”.

The models don’t account for that.

vikingvistaApril 5, 2011 at 8:42 pm

“The models don’t account for that.”

They could. But they don’t. And if they did, there would be plenty of other critical factors they miss.

But besides the information problem, most macro model mongers make a fundamental modeling error. They fail to incorporate known deterministic factors (beyond their choice of a tautological accounting identity). It isn’t just unintended omissions due to the fact that they do not understand economics, it is that they are of the philosophical belief that known economic truths are irrelevant, and all that matters are data.

Stanton YApril 5, 2011 at 6:13 pm

This is amazing–I just sent in an op/ed piece reflecting on something just like this. Wasn’t it Mises who said that economic science was the pith of life?

You Know WhoApril 5, 2011 at 9:38 pm

Economics really is beutifull.
I also like the charachatures on the margins (:
And I know you.

I couldn’t agree more. I am a economics major at Penn State and I feel that lots of important concepts are ignored because they are “too complicated”. Thus, economics here ends up being dumbed down graduate school economics and we get neither the mathematical approach nor the philosophic/historical approach that is necessary to understand economics. In addition, the approach here is very anti-Schumpeterian (one-dimensional), ignoring other important fields. particularly other social sciences, that can help to explain what is going on in the economy.

Thankfully the classes here are not that difficult for me. This gives me the opportunity to learn economics on my own via books, podcasts (particularly Econtalk), and other forms of media. However, many economics majors are not as motivated as I am and they fail to learn economics, despite spending tens of thousands of dollars on their education.

Mark TApril 6, 2011 at 10:34 am

Brilliant comment. Your second sentence is absolutely right and pithily sums up the shortcoming on the discipline.

AnotherphilApril 6, 2011 at 12:12 pm

II was an Econ major (when the College of Business had Econ as a major)-early 1980′s, so perhaps my experience in Happy Valley was different than Zach’s- are they still having those droning lectures in the Forum or Eisenhower auditorium? I’m guessing everything is different except for Paterno.

For the most part, I enjoyed economics because among the “social sciences”, the faculty was the most grounded in reality and focused on the subject matter, rather than using the course as a pretense to inflict personal political viewpoints on a powerless audience.

An example to the contrary is the following: As a freshman at a “Commonwealth Campus”, I was treated to a forty minute tirade, with an adjunct instructor seething with rage the day after the 1980 election. It began with “I hope you are all happy today, in as much as YOU (the 20 or so in the class, who even if we all voted for Reagan had no effect on the election, but he had no idea if we voted or how) are responsible for this (Reagan’s election was the “this” to be understood) and I hope you are all happy when you are freezing you’re a**es off in Afghanistan next year”. Unfortunately, the class was an intro rhetoric and composition class, not poli-sci and that was a misuse of our time.

However, after I graduated I began to question the insular canon I was provided- Basic Macro and Micro was largely taught from Campbell R. McConnell’s book. Amazon describes the 15th edition as follows: “15e is the best-selling textbook and has been teaching students in a clear, unbiased way for 40 years.”. Whatever edition was used in 1982 gave plenty of mention of Keynes, Samuelson, and Marx was treated as an “economist”, but I don’t recall ever hearing about Bastiat, Hayek or Mises. Now, as an adult I understand that to be a glaring omission, whether or not the result of bias.

Hell, we even covered those inane models that used matrices (Kondratieff?) that purported to be able to maximize the output of national economies-and this would have been a great place to discuss Hayek’s “pretense of knowledge” critique, no?

With regard to the hypermathematization of economics, I had intended to pursue a Master’s in Econ, but ran into a class called “Econ 480 Mathematical Economics”. Unfortunately, at the time I was having some health issues and was forced to withdraw but even under perfect conditions, I doubt I would have been able to pass the class. One of the exam questions was “prove function F is continuous between the following limits”. Apart from the relevance (this is pure math, not a mathematical appication of economics), the method used to construct such a proof (L’Hopital’s rule?) wasn’t in the chapters identified as covered by the exam-it was in a chapter later in the book, supposed to be covered by the second exam. Those who complained were met with what Amity Shlaes so artfully described as “whithering contempt”, for having taken a class without proper preparation, despite the fact the authors of the textbook obviously felt it wasn’t an expected prerequisite.

Zach, I think your inquiries outside of the classroom show someone who understands that a proper education should provide more questions than answers. People whose learning is limited by their formal education grow up with epistemic arrogance, and are unpleasant and myopic-in short like Obama and his cadre of statist shock troops.

I can only envy somebody who is young enough to have been “digital from birth”, with the internet to puncture the insular balloon of the academy. Now if you can just get significant numbers of fellow students to understand and question their affliction of Stockholm Syndrome when they allowed themselves to be used as political props when they are dispatched to protest en masse by their professoriate against fiscal reality in Harrisburg, it will be a great day.

And I can’t tell you how many times I have buried Daniel. But he’s like Rasputin. You can shoot him, strangle him, drown him, and still he pops up, with that silly grin on his face, mocking the natural order of the Universe.

AnotherphilApril 6, 2011 at 12:15 pm

No real economist uses graphs or equations, anywhere.

You are kidding, right?

EduardoApril 6, 2011 at 12:24 pm

he is probably assuming a world in which he is the only economist.

vikingvistaApril 6, 2011 at 5:33 pm

If he couldn’t read, he’d be proclaiming that the printed word has no place in economics as well.

By the way, I can’t tell you how many times I’ve had this “debate” on the Internet, first at Austrian Economists, now Coordination Problem, and here, too, and it always goes like this, with Lesvic asking for just one example of a graph or equation “indispensable” to economics, predicting that such example will never be forthcoming, and his antagonists outraged at his high-handedness in demanding it. Viking (now Vesuvious) Vista will pipe in with words he has put in my mouth, knocking down the straw man Lesvic he has set up, but never contronting the real one. Watch it all happen again.

vidyohsApril 5, 2011 at 8:33 pm

Aw man, are you pessimistic by nature, or naturally pessimistic? Could be one or the other, right?

vikingvistaApril 5, 2011 at 8:51 pm

“Lesvic asking for just one example of a graph or equation “indispensable” to”

There is no graph or equation (or word or sentence or language or symbol or utterance) indispensable to anything. An idea can be communicated in countless ways. Not understanding those graphs, by your own pathetic repeated admissions, hardly leaves you in a position to comment on them.

Vesuvius Vista is less offended at your numerous needling falsehoods than your complete lack of effort in putting those few rattling IQ points of yours to use.

Graphs are only useful insofar as they can visually represent something useful that can be explained.

vikingvistaApril 6, 2011 at 5:56 pm

Insofar as that is never, you do agree.

vidyohsApril 5, 2011 at 8:37 pm

Don,
Tks for an excellent post. I am going to pass it on to my looney left friends (real, honest to God) that think that Kroger’s supermarkets is showing their greed by lowering prices. I keep hoping they will wake up.

vikingvistaApril 5, 2011 at 8:52 pm

And what do you think your friends would say about Kroger’s if they RAISED their prices?

Bravo, Stephen. I had completely the opposite experience in my first couple of economics classes.

I particularly like your parting thought. Would be nice if some economists understood that.

waterzooiApril 5, 2011 at 10:35 pm

Interesting….I became interested in economics as a business major at Baltimore City Community College. I had a professor for Principles of Macro and Principles of Micro, a Nigerian who spent the whole class reading clippings from the newspaper and challenging us to find the economics in it. I wrote a paper in the class on whether red light cameras were for safety or for profit. His ability to teach the economic way of thinking with no textbooks and a modicum of graphs…definitely no equations…was what inspired me to major in economics.

Keynes taught this way – apparently he would take newspaper clippings at the start of each class and ask the class “what economic theory underlies the claims of this article?”

EconomiserApril 5, 2011 at 10:43 pm

I hated intermediate macro. It was nothing but an endless string of equations with little explanation and no context. I felt like I was in a math class. The professor was a very nice guy but it didn’t help that his English wasn’t great.

Students would benefit greatly from having more professors like Drs. Boudreaux and Roberts, who understand that economics is more than plug-and-chug formulas.

Amen to that. And I think we must allow for the fact that if they didn’t incorporate some of the usual academic BS in their classes, they’d be drummed out of the union.

Methinks1776April 5, 2011 at 10:49 pm

Same experience for intermediate macro. Hard to hate a class where you can just plop down formulas as answers to test questions and get an A, though. Easy to forget everything you “learned”.

vikingvistaApril 5, 2011 at 11:41 pm

“with little explanation and no context”

Can’t deliver what doesn’t exist.

EconomiserApril 5, 2011 at 11:02 pm

Sometimes I wonder – do professional economists really believe that the formulas they endorse are an accurate representation of reality? They are very smart people. Surely they must know that their models involve so many assumptions and guesses as to be practically worthless in the real world. Yet government economists make precise predictions based on those models all the time. I don’t get it.

Thomas Sowell wrote two Economics textbooks with not one chart or graph in them. So it can be done. But I am not sure it should be done. You should probably at least have a supply and demand graph sometime during an introductory class.

wittyUserNameApril 6, 2011 at 8:29 am

The most recent Econtalk refers to an open source process. I am not sure that this forum would mirror that process but I think it is a good start. So: What would you want a student to learn in a college level first Economics course?

EduardoApril 6, 2011 at 9:24 am

Keynes said this about economics:
“Economics is a moral science.. it deals with introspection, values, motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous.”
And here he made an interesting comparison with physics:
“It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the centre of the earth”

Googling it was the first thing I did, and I just got a bunch of mentions without a citation and citations to the collected writings – I figured it was in the collected writings (that’s the idea of collecting someone’s writings, right?), I was curious where it was from and rather than tracking it down further it seemed likely Eduardo knew off the top of his head.

That’s a winning combination, Lord Keynes and Count Kuehn, sucking the blood, like a Count Dracula, out of economics and these discussions of it.

EduardoApril 6, 2011 at 11:49 am

DG Lesvic,
I am not answering your comment because there is no substance in it.
I just want to tell you that your blog is a real piece of shit.
Please, answer me quoting Goebbels or talking about communism vs capitalism like our grandfathers used to do!

EduardoApril 6, 2011 at 11:52 am

didn’t you like the quote because it was Keynes? (sorry i didn’t understood the meaning of : “how do I keep John K from being a smart ass?”)

I was calling John K a smart ass because he furnished a “let me google that for you” link as if it wasn’t the first thing I did. He can be a real troll – never mind – didn’t mean to pull you into that squabble.

I learned more economics from reading Thomas Sowell’s “Basic Economics” than the 3 semesters I took as an undergrad.

As I recall, it did not include any graphs are equations.

It did contain interesting analysis of real world examples that I could identify with. Some of those examples stay with me to this day, and it’s been awhile since I first read it.

I’m open to the idea that the 3 semesters helped prepare me for “Basic Economics”, but I like to think those were not a prerequisite.

EduardoApril 6, 2011 at 10:28 am

I agree with you! The practical examples are the best way to learn economics

John VApril 6, 2011 at 10:28 am

Agreed. Sowell’s book is excellent.

Mark TApril 6, 2011 at 10:39 am

A wonderful post and enlightening comments. I will not bore the readers with a recitation of my own successful but abortive pursuit of an economics major but my experience and conclusions resemble those of the author and most commenters. I too am grateful for the George Mason school for reviving my interest in the field and I believe dramatically advancing the discipline as well.

DaveApril 6, 2011 at 12:01 pm

Was Stephen recommending Russ’s book to Don? Or was this an email he sent to someone else?

ettublogeApril 6, 2011 at 12:26 pm

Seth is right. Add in Sowell’s “Applied Economics”, Hazlitt’s “Economics in One Lesson”, Callahan’s “Economics For Real People”, Russ’s book, articles by Walter Williams, Mises website, Freeman website and Don’s blog. All you need without a formula or graph.

danApril 7, 2011 at 10:51 pm

It helps to pick up an used Econ 101 text book for an introduction to all of the terminology and basics. Then, go on to Sowell. I would suggest Sowell’s other books, ‘Basic economics’, ‘Economic Facts and Fallacies’, ‘intellectuals and society’, and ‘Housing Boom and Bust’. I just love Sowell’s material.

Wait a sec, you mean that Macro class I took wasn’t a class on economic illustration interpretations wasn’t about graphs, charts and forumulas? I want my money back!

After my Intro to Macroeconomics class I skipped taking Micro. As I pursued my degree I needed another easy credit in the social sciences section. So based on reading this blog, a few popular-econ books, and a healthy diet of libertarian logic, I took the CLEP:

$70 CLEP test cost
$90 fee to the university (to add those new credits to my records)
$0 Cafe Kayek
$0 Econlib
$22 Half the cost of my used, 7 year old Macro econ book (which I used for refreshing on the graphs)
———-
$182 for 3 credit hours – not accounting for cost of time over three weeks of “cramming”, and no general risk to GPA (pass/fail test). Costs had I taken the class at the university: $1350 + book and supplements and risk to GPA

danApril 7, 2011 at 10:45 pm

Kinda makes the statements by Matt Damon’s character in ‘Good Will Hunting’ have a ring of truth, and something for us all to consider.
That would be the part where he condescends to the elitist Harvard student about the costs of a university education compared to the costs of a library card and some late fees.
Spend more time reading and less with foolish tv programs like
The Jersey Shore’.

JimSApril 7, 2011 at 9:59 pm

This letter makes me reflect on how lucky I was to have Paul Heyne at UW for my intro econ classes.